Thursday, August 13, 2009

Landsburg versus Mankiw on cap-and-trade: CBO provides the answer

Greg Mankiw has become a sharp critic of the Democratic "cap and trade" plan to limit carbon emissions that will give away almost all permits to emit CO2 to business interests, instead of auctioning them off -- costing the government more than $700 billion of revenue over 10 years.

In his recent NY Times column on the subject he quotes Obama himself saying: "One of the mistakes the Europeans made in setting up a cap-and-trade system was to give too many of those permits away."

And he missed an even tougher quote from Obama's budget director, Peter Orszag, who earlier this year argued against giving away the permits, saying to do so

"would represent the largest corporate welfare program that has ever been enacted in the history of the United States.

"In particular, all of the evidence suggests that what would occur is the corporate profits would increase by approximately the value of the permits. So that -- whatever that is, $600 billion, $800 billion, whatever the value is, would go in a sense almost directly into corporate profits... [WSJ]

But now Stephen Landsburg makes an agrument in defense of the "great give away" as a matter of principle -- of fundamental justice.

as Professor Mankiw points out, that goal [reducing CO2 emissions] is served equally well whether we give the permits out for free or require firms to buy them.

But the latter option not only creates an incentive for good future behavior; it simultaneously punishes bad past behavior. The firm that recently invested in a million-dollar machine that now can't be operated without a half-million dollar permit is effectively paying a half-million dollar fine for behavior that was perfectly legal a year ago ... ought they be punished ex post facto?...

There are two competing principles here. The first principle is: Nor shall private property be taken for public use without just compensation, a principle enshrined in our Bill of Rights. Arguably, in the case of the million-dollar machine, the government has effectively taken half your machine from you for the public purpose of cleaning the air; therefore you should be entitled to just compensation. One form of compensation would be to give you your permit for free...

One problem with applying this principle is that a government with the power to punish bad behavior ex post facto is also a government with the power to punish good behavior ex post facto. If today they can retroactively punish overinvestment in bad technologies by making people buy cap-and-trade permits, then perhaps tomorrow they can retroactively punish saving by taxing our 401Ks. The fact that a principle is capable of being abused does not invalidate the principle, but it does suggest we might want to be cautious about invoking it.

In this case, I'm not sure which principle should prevail. I am, however, sure that these are the principles at stake, and any useful debate will have to address them.

That's why I'm so disappointed to see am economist as smart as Professor Mankiw arguing in essence that we should sell cap-and-trade permits just because it's a good way for the government to get its hands on a big pile of money...

The real question on the table is: Do we want to empower our government to punish bad behavior that was perfectly legal when it occurred?

So which view of "principle" is correct? Is the permit give away "the largest corporate welfare program ever enacted"? Or is it just compensation to prevent ex post facto seizure of wealth by the government?

Well, it often happens that conflicts of principle dissolve pretty quickly upon examining data -- and even before this debate arose, the Congressional Budget Office conducted a quantitative examination of this very issue, reporting [.pdf]:

Free allocation is meant to compensate shareholders in those companies for any declines in stock value they might experience because of the cap.

However, available evidence indicates that only a small fraction of the CO2 allowances would be needed to provide such compensation under a U.S. cap-and-trade program.

Researchers generally conclude that less than 15 percent of the allowance value would be necessary to offset net losses in stock values in both "upstream" industries (such as suppliers of coal, natural gas, and petroleum) and energy-intensive "downstream" industries (such as electricity generators, petroleum refiners, and metal and machinery manufacturers).

The reason is that the cost of holding the allowances would generally be reflected in the prices that producers charged, regardless of whether those producers had to buy the allowances or were given them for free.

By that the score looks like: Largest corporate welfare program in history 1, Principled compensation against ex post facto taking 0.

Interestingly, Landsburg does note that giving away the emmission permits over-compensates businesses for the harm they would suffer from cap-and-trade, but only in a parenthetical...

(Actually, a free permit amounts to overcompensation, because cap-and-trade will lead to higher prices for carbon-based products, which already partly compensates the affected firms. So maybe our principle dictates that permits should be cheap but not free.)

... and doesn't mention that the overcompensation is on a scale of maybe 6- or 7-to-1 ... maybe 600% of the harm done

If he had mentioned that, he wouldn't have had so much to be disappointed about in Professior Mankiw, or such a point of justice to raise.

Footnote: As the few regular readers of this blog know, I'm no fan of finding new and easy ways to feed big piles of money to the government -- but I'm no fan of massive corporate welfare schemes either.